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Almost since Bitcoin arrived on the financial scene in 2009, traders
and exchange operators began contemplating the prospects for a
self-regulatory organization that would be organized by bitcoin
participants for the purposes of outlining and recommending best
practices.
Now, more than four years on, an SRO
in the spirit of the National Futures Association and National
Association of Realtors could be emerging for the disruptive Bitcoin
cryptocurrency and other digital assets. The Committee for the
Establishment of the Digital Asset Transfer Authority is set to announce its launch Tuesday in conjunction with several leading industry participants and the well-connected Promontory Group as an advisor.
As
a longtime cryptocurrency advocate and the recently appointed executive
director of the Bitcoin Foundation, I welcome the emergence of SROs.
(Unlike the foundation, the D.A.T.A. will cover a broad range of virtual
currencies, including Ven and Ripple). A non-governmental body formed
to promote good industry behavior has a distinctly free market heritage.
Groups born out of mutually-beneficial community trade can also define a
set of common principles that they want to abide by referred to as lex mercatoria.
This is Latin for "merchant law," the body of commercial law used by
merchants throughout Europe during the medieval period emphasizing
contractual freedom and alienability of property. Merchants relied on this legal system they developed and administered while shunning legal technicalities and deciding cases ex aequo et bono – "from equity and conscience."
Although
SROs can be extremely beneficial in advancing an industry, clear
political lines must be drawn to mitigate the risk that an SRO would be
co-opted by government and this is where it gets tricky. To avoid more
direct and onerous regulations, the government may ask the SRO for
certain guidelines or rules to be incorporated among its membership. If
such modifications are objectionable to the majority of industry
participants, the SRO faces the dilemma of challenging the authorities
and risking its relevance or being complicit in harmful and
over-reaching backdoor legislation.
The path of complicity
ultimately leads to an SRO that has strayed from its core constituency
and could be absorbed by the government as a direct regulatory body. The
SRO should periodically conduct a reality check by remembering
Voltaire's words: "To learn who rules over you, simply find out who you
are not allowed to criticize."
From a purist perspective,
challenging the authorities on points of principle may not necessarily
result in irrelevance but it would shift the group's mandate to one of
advocacy and most likely even criminal defense. This does not have to be
viewed as a negative outcome, but it does have to be anticipated.
As
self-regulatory organizations are excellent non-governmental solutions
for industry best practices, they need to be vigilant about maintaining
the integrity of the original mission. In the case of bitcoin as a negotiable
digital asset class, the protection of core fundamental attributes
includes perfect fungibility, payment irreversibility, and user-defined
privacy. Also considered sacrosanct for the Satoshi Nakamoto Bitcoin
protocol would be the 21 million limitation on coin supply and the
roughly 10-minute interval for new "blocks" of transactions added to the
public ledger known as the block chain. That interval is a function of
the self-adjusting difficulty for bitcoin mining. (The more distributed
computing power dedicated to securing and verifying transactions on the
network, the harder it becomes for any miner to solve a mathematical
problem in order to "find" the next block for the public ledger and earn
newly-created bitcoins.)
Anything different simply wouldn't be
Bitcoin – it would be an alt-coin. A toaster does one thing and it does
it amazingly well. It makes toast. If you modify it and ask it to do
something else, then it's no longer a toaster.
Recently, Govcoin
has become a metaphor for alterations to the core bitcoin protocol that
reduce its fungibility, irreversibility or privacy to conform to
certain government specifications for an "appropriate" digital currency.
In the Juan Llanos' article
with the sensationalist title, "The Hidden Rule that Could Kill
Bitcoin's Irrevocability," the author makes the point that bitcoin's
privacy and irreversibility could be under attack via ignorant
legislation that cannot comprehend what it is attempting to regulate.
Llanos states, "It is no surprise that regulation and compliance often
set the boundaries of product design. In the case of crypto-currencies,
however, don't these rules cut through the fundamental features of
digital [peer-to-peer] payments that make them so disruptive?"
The Consumer Financial Protection Bureau
has not yet confirmed to what extent the implementation of Regulation E
by money transmitters will be applicable to licensed virtual currency
providers. Also known as the Remittance Transfer Rule,
this amendment to Regulation E mostly overlaps with measures in place
at the state level and compliance will be required by Oct. 28. It
requires, among other items, prepayment disclosure, transaction
receipts, and transaction cancellation within prescribed time limits.
Although
it is technically possible to delay a bitcoin transaction, a full
reversal of a transaction would require unacceptable developer
complicity at the core protocol level and probably the introduction of
an intermediary of some sort. This would undermine Nakamoto's vision of a
financial system that did not require trusted third parties.
Examples
of what would be considered acceptable variables to modify within the
core Bitcoin protocol are the block size limit and the proof-of-work
algorithm. A block size change would be anticipating transaction
throughput and increases in storage and network bandwidth. Changes to
the SHA-256 algorithm for proof-of-work would be considered technically
feasible and prudent given certain advances in cryptography. However,
each of these modifications would require majority consensus of the
bitcoin miners to prevent a critical "fork" of the bitcoin block chain.
Think
about physical paper cash which everyone has the right to use today.
The supreme features of physical paper cash, other than security and
divisibility, are fungibility, irreversibility, and privacy.
Digital
cryptocurrency assets such as bitcoin do not add anything new to that
primary feature set. An SRO in the digital asset industry should not
remove any.
Fungibility refers to a commodity possessing
the trait of mutual substitution among its individual units. A crumpled
$20 bill found between the sofa cushions is as good as a crisp one
handed out by a bank teller. In the context of digital currency, this
means the blocking or banning of "tainted coins" is not permitted. Just
because someone once used a bitcoin to buy drugs, it shouldn't prevent a
subsequent owner to use it to buy socks or baklava or MP3s.
Irreversibility means that payments in the unit are final and irrevocable – no chargebacks. User-defined privacy
refers to a sliding scale, based on individual preference, as to how
many details of a particular transaction are associated with the user.
"Privacy
on the network begets transparency," writes my colleague Patrick Murck,
general counsel at the Bitcoin Foundation, in an article on the Cato
Institute's Cato Unbound blog. "You can't expect participants
to allow full financial transparency at the institutional level if the
participants can't choose to guarantee the privacy of their individual
transactions."
Rather than a failed patchwork of individual state
money transmitter rules, Murck says, "the preferred outcome would be
home-rule and reciprocity amongst the states allowing states to compete
for industry by creating efficiency and clarity in the regulatory
process." Furthermore, multi-state regulation has failed because each
state is not required to respect the judgment of another where a company
is domiciled.
Over-regulation tends to drive innovation to more lightly-regulated
jurisdictions or underground where it thrives. And, this is even truer
with the cryptographic bitcoin. Although not government's intention, a
throttled and neutered bitcoin in the "official" economy would
ultimately enhance its overall effectiveness via increased anonymizing
measures and more robust decentralization.
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